6.0 MAIN CONTENT
3.1 Financial Management: Definition of Term
Financial management can be defined as: the management of the finances of a business/organisation (health institution) in order to achieve financial objectives (Tutor2u, 2009). Financial management entails planning for the future of a person or a business enterprise to ensure a positive cash flow. It includes the administration and maintenance of financial assets. Besides, financial management covers the process of identifying and managing risks.
The primary concern of financial management is the assessment rather than the techniques of financial quantification. A financial manager looks at the available data to judge the performance of enterprises.
Managerial finance is an interdisciplinary approach that borrows from both managerial accounting and corporate finance.
Some experts refer to financial management as the science of money management. The primary usage of this term is in the world of financing business activities. However, financial management is important at all levels of human existence because every entity needs to look after its finances (Tutor2u, 2009).
3.2 Objectives of Financial Management
Taking a health enterprise as the most common organisational structure, the key objectives of financial management would be to:
• create wealth for the business
• generate cash, and
• provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested.
3.3 Elements of Financial Management
There are three key elements in the process of financial management:
(1) Financial Planning
Management needs to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit.
In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions.
(2) Financial Control
Financial control is a critically important activity to help ensure that the business is meeting its objectives. Financial control addresses questions such as:
• are assets being used efficiently?
• are the businesses assets secure?
• does management act in the best interest of shareholders and in accordance with business rules?
(3) Financial Decision-making
The key aspects of financial decision-making relate to investment, financing and dividends:
• investments must be financed in some way – however, there are always financing alternatives that can be considered. For example, it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers
• a key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further.
SELF ASSESSMENT EXERCISE 1. Define financial management
2. What are the objectives of financial management?
3.4 Financial Management Levels
Broadly speaking, the process of financial management takes place at two levels. At the individual level, financial management involves tailoring expenses according to the financial resources of an individual.
Individuals with surplus cash or access to funding invest their money to make up for the impact of taxation and inflation. Else, they spend it on discretionary items. They need to be able to take the financial decisions that are intended to benefit them in the long run and help them achieve their financial goals.
From an organisational point of view, the process of financial management is associated with financial planning and financial control.
Financial planning seeks to quantify various financial resources available and plan the size and timing of expenditures. Financial control refers to monitoring cash flow. Inflow is the amount of money coming into a particular company, while outflow is a record of the expenditure being made by the company. Managing this movement of funds in relation to the budget is essential for a business (Economy watch, 2009).
3.5 Financial Management Practice
The financial management of an enterprise first requires appraisal of alternative strategies for allocating the limited resources available. Once a preferred strategy is identified, a detailed budget is prepared to carry it out. Then in the course of implementation, expenditures are monitored in relation to budgeted levels (Mills, 1990a, 1990b). Financial management practice, therefore, is discussed under three headings:
• resource allocation decisions
• performance budgeting
• cost analysis
3.5.1 Resource Allocation Decisions
The fundamental aim of the design of health programmes is to achieve desired results at minimum cost. This is the essence of Cost Effectiveness Analysis (CEA) (Reynolds & Gaspari, 1985). In recognition of the special importance of intangible benefits in connection with health and other social services, the economic orientation of CEA has been broadened to form Cost Utility Analysis (CUA) (Gold, Russell, Siegel, & Weinstein, 1996; Torrance, 1986). The notion of health for all has further directed attention to the distribution of benefits along with overall levels of achievement. Thus, equity has become a prime concern (Musgrove, 1986). More recently, we have come to appreciate the labour intensive nature of health care and its effect on recurrent costs. One-time development costs incurred with donor support to improve service coverage leads to an ongoing recurrent cost commitment normally borne by the host country government to maintain the capability that has been developed. Issues of programme sustainability and affordability have, therefore, come to the forefront (Abel-Smith & Creese, 1989, Bossert, 1990; Lafond, 1995; Olsen, 1998;
Prescott & De Ferranti, 1985). This interest has been heightened by growing concern over quality issues which can be costly. The question is raised whether improved quality, achieved at a cost, carries with it a level of client satisfaction that results in a willingness to pay for the
added costs. Thus, issues of cost recovery enter the equation (Creese &
Kutzin, 1995; Kanji, 1989; Knippenberg, Reinke, & Hopwood, 1997).
These multiple desires are not necessarily mutually compatible. For example, the most cost effective strategy in a given situation might focus on a readily accessible urban population, but this approach would be unlikely to satisfy even minimum criteria of equity. Sound and reliable appraisals of the trade-off between cost-effectiveness and equity require explicit comparisons of each evaluative indicator. Although cost- effectiveness measures have been well defined, the meanings of equity, quality, and sustainability are still somewhat vague. Financial analysis methods must be defined to clarify the various evaluative measures and lastly, facilitate integrated analysis of the trade-offs required among them (Reinke, 2001).
3.5.2 Performance Budgeting
Too often, budgeting is merely an exercise in which planners take last year’s allocation and project a certain percentage increase this year as reasonable or feasible. Or perhaps, a 15% increase in the personnel budgets is considered necessary, while a 10% increase in the transport budget would be satisfactory. Budgets based upon line item inputs like personnel, transport, drugs, and maintenance, apart from the outputs expected, are necessarily arbitrary and not easily justified.
Programme budgets are somewhat more satisfactory because the inputs are related to areas of activity. Thus, the judgment might be made to give higher priority to family planning and increase that programme budget by 20% while holding the budget for communicable disease control to last year’s level. Still, as a budget of resources only, albeit for selected purposes, the programme budget is of limited value to programme managers for tracking performance during the budget year, family planning expenditures have consumed 40% of budgeted funds for family planning, or 80% (40/50) of expected levels for the period.
Perhaps cost savings have accrued as a result of efficient use of resources, but what if only 30% of planned contacts for the year have been made during the first 6 months. This presents a picture of relative inefficiency, in which 40% of budgeted resources were consumed in providing 30% of intended services. For management action purposes, it is clearly preferable to relate inputs and outputs explicitly (Reinke, 1988b).
3.5.3 Cost Analysis
Although cost analysis techniques comparing actual experiences with budgeted expectations have been introduced, further elaboration of costing methods is needed. First, it is necessary to understand how costs are interpreted differently at various stages of budgeting and cost accounting (Creese & Parker, 1994). To illustrate, consider a presently used piece of equipment that is to be replaced by a more automatic labour-saving instrument. Specifically, the old equipment was purchased 2 years ago for N48, 000 and was expected to last for 6 years, and the new instrument costs N70, 000 and is expected to remain serviceable for 5 years.
In the resource allocation decision to purchase, the capital cost of the new equipment enters into the calculation, but not the initial cost of the existing instrument, as this expenditure has already been expended and is not subject to reversal. An issue in the allocation decision is whether the superior performance of the new instrument justifies its purchase.
If purchase of the new equipment requires full payment in advance, the next budget must include the entire cost of the new equipment, but nothing for the old. In contrast, the accounting records will show entries for both instruments. One-sixth (N8,000) of the original cost of the old equipment is to be accounted for during each year of its expected life, and now N14,000 will be added during each of the 5 years that the new instrument is expected to be in use. The thinking behind this procedure is that because the equipment is anticipated to produce service benefits over time, its cost should be similarly allocated in order to permit determination of cost per unit of service. Cost calculations, then, must suit the purpose for which the determination of cost is being made. In particular, accounting records are of limited value in analysis of cost effectiveness.
4.0 CONCLUSION
It is hoped that you have gained a better understanding of financial management which was defined as: the management of the finances of a business/organisation in order to achieve financial objectives. Its objectives among many include: creating wealth for the business, generating cash and providing an adequate return on investment.
Financial planning, control and decision were also recognised as key elements of financial management. Also, the level of financial management can be at the individual or organisational levels. This unit concluded with descriptions of the following: financial management practices: resource allocation decision, performance budgeting and cost analysis.
5.0 SUMMARY
This unit outlined the following:
• financial management: definition of term
• objectives of financial management
• elements of financial management
• financial management: levels
• the practice of financial management
ANSWER TO SELF ASSESSMENT EXERCISE
Financial management can be defined as: the management of the finances of a business/organisation in order to achieve financial objectives (Tutor2u, 2009). Financial management entails planning for the future of a person or a business enterprise to ensure a positive cash flow. It includes the administration and maintenance of financial assets.
Besides, financial management covers the process of identifying and managing risks.
Objectives of Financial Management:
• create wealth for the business
• generate cash, and
• provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested
6.0 TUTOR-MARKED ASSIGNMENT 1. Define financial management
2. What is the role of the following in financial management?
a. Resource allocation decisions b. Performance budgeting c. Cost analysis
7.0 REFERENCES/FURTHER READING
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Geneva: WHO.
Abel-Smith, B. (1994). An Introduction to Health: Policy, Planning and Financing. London: Addison Wesley Longman Ltd.
Arvid, R. J. (1976). Management, Systems, and Society: An Introduction. Pacific Palisades, Calif.: Goodyear Pub. Co.
Bossert, T. J. (1990). Can they get along without us? Social Science and Medicine, 30(90), 105-1032.
Campbell, C. (2007). Essentials of Health Management Planning and Policy. Lagos: University of Lagos press.
Creese, A. & Parker, D. (1994). Cost Analysis in Primary Health Care:
A Training Manual for Programme Managers. Geneva: WHO.
Creese, A. & Kutzin, J. (1995). Lessons from cost Recovery in Health.
Discussion paper No. 2. Geneva: WHO.
Economy watch, 2009. Financial management. Retrieved from:
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Gold, M. R., Russell, L. B., Siegel, J. E. & Weinstein, M. C. (1996).
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Kanji, N. (1989). Charging for Drugs in Africa. UNICEF’s “Bamako Initiative”. Health Policy and Planning, 4(2), 110-120.
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Lafond, A. K. (1995). Research on Sustainability in the Health Sector.
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Merson, M. H., Black, R. E and Mill, A. J. (2001). International Public Health: Disease, Programmes, Systems and Policies. Maryland:
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Mills, A. (1990a). The Economics of Hospitals in Developing Countries, Part 1: Expenditure Pattern. Health, Policy and Planning, 5(2), 107-117.
Mills A. (1990b). The Economics of Health in Developing Countries, Part 11: Costs and Resources of Income. Health, Policy and Planning, 5(3), 203-218.
Musgrove, P. (1986). Measurement of Equity in Health. World Health Statistics Quarterly, 39(4), 325-335.
Olsen, I. T. (1998). Sustainability of Health Care: A Framework for Analysis. Health Policy and Planning, 13(3), 287-295.
Prescott, N. & Ferranti, D. (1985). The Analysis and Assessment of Health programmes. Social Science and Medicine, 20(12), 1235- 1240.
Reynolds, J. & Gaspari, K. C. (1985). Cost-Effective Analysis. Chevy Chase, MD: Center for Human Services.
Reinke, W. A. (1988). Health Planning for Effective Management. NY:
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Reinke, W. A. (1995). Quality Management in Managed Care. In: H.
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Reinke, W. A. (1999). A Multidimensional Programme Evaluation Model: Consideration of cost Effectiveness, Equity, Quality and Sustainability. The Canadian Journal of Programme Evaluation, 14(2), 145-160.
Reinke, W. A. (2001). Health Systems Management. In: M. H. Merson, R. E. Black, and A. J. Mill, (eds.). International Public Health:
Disease, Programmes Systems and Policies. Maryland: Aspen Pub.
Tutor2U (2009). What is Financial Management? Retrieved from ://tutor2u.net/business/accounts/finance_management_intro.htm.